Are you a fan of David and Goliath courtroom dramas?
You know the sort of thing; an individual takes on the full legal firepower of a huge corporation in a tense courtroom battle over some wrong doing. Films such as The Verdict, Erin Brockovich and A Civil Action are all great entertainment, but have you ever considered how these legal cases are funded?
Well, in a growing number of cases it is through litigation finance.
There are many cases that complainants would like to bring to court, but where they simply cannot afford the large sums required to pay their legal costs. So, in order to fund their lawsuit, they may well turn to a third party.
These firms will lend the money required, in return for a slice of the costs and damages awarded — if the case is settled or won at trial.
Litigation finance is not a new phenomenon. Indeed, it has been gaining widespread acceptance over the last 30 years in countries such as Australia, Canada, the US and the UK. But, what is new, is that it is now becoming increasingly available to private investors.
Whereas it was once the preserve of hedge funds, family offices, private equity and other institutions, it is now possible for regular Joes to access this new asset class.
Because it is uncorrelated with other assets, and potentially very lucrative — AxiaFunder claim an expected annual return of 20-30% — it could make for an excellent addition to your portfolio.
The skill for the litigation finance provider, is in selecting cases that have a high probability of being settled out of court, or won in the courtroom within an acceptable time period — usually no more than three years.
They also need the winning cases to return a high multiple of the initial investment. AxiaFunder target a reward that is at least five times the cost of litigation.
Once a suitable case has been selected, the funding goes towards paying the legal and associated costs for the claimant. Then it’s simply a case of sitting back and waiting for the lawsuit to conclude. It can either be settled before the court hearing ever begins, won in the courtroom or, of course, lost in the courtroom.
These neatly defined end points mean that investors have a clear exit strategy and usually a good feel for the length of the financial commitment.
Clearly, winning a case is the best outcome. The litigation finance company will receive their initial investment back plus a pre-agreed slice of the award.
However, if you lose the case the investors will be responsible for the costs they’ve incurred and the winning sides legal costs, although this tends to be covered by insurance.
There are several different ways for an investor to get involved in this fascinating new asset class. Although for some of them, you may need to certify yourself as being a suitable investor. Let’s have a look.
The Just ISA
First up, an Innovative Finance ISA that allows you to invest in a three or five-year bond paying 8% interest per annum.
The invested money follows a rather convoluted route to a Jersey operating company where a litigation advisory committee — using a strict selection process — will recommend which legal cases the money will be invested in.
Once the necessary insurance is in place, the money is passed to the law firms who are actually fighting the selected case and the wheels of justice crank into action.
So, just to be clear, as an investor, you are receiving a fixed return of 8% per year, not sharing directly in the proceeds — or losses — of a specific case. The company behind the Just ISA specify a minimum £2,000 investment and predict a 90% success rate for the cases they invest in.
So, if you are comfortable with the ethics — this isn’t ambulance chasing — and are not concerned about personally picking which cases to back, this could be an interesting route into litigation funding.
But what if you want to invest in specific cases? Well, a newly launched crowdfunding platform may offer a solution.
This platform takes a different approach to litigation funding — you get to choose which cases to invest in. The crowdfunding model means that investors’ money will be lumped in with other investors and used to buy shares in a separate case-specific Special Purpose Vehicle (SPV).
AxiaFunder themselves are clear that this is a high risk strategy. If the case wins, happy days. You could find your initial investment multiplied several times over (and that will be tax free if you use an IFISA).
However, if it is kicked out, you’ll lose the lot. With such a high-risk approach to investing, you should spread your cash across multiple cases.
It’s still early days for AxiaFunder, and their two featured cases only required £12,000 each in funding. But it’s a good idea and I’ll be interested to see how they develop.
Burford Capital Ltd
If the two approaches above are a little off-piste for you, then you could follow Neil Woodford’s lead and invest in Burford Capital.
They are the biggest operator in litigation finance and are listed on London’s AIM stock market. That means that you can simply buy and sell shares in them like any other listed company.
As well as litigation finance they are also involved in risk management, asset recovery and a range of other legal and advisory activities.
Neil Woodford — the well-known fund manager — has Burford Capital’s shares as the third highest holding (5.78%) in his Equity Income Fund.
Although, he has struggled of late, it is definitely a stamp of approval for Burford Capital and this asset class that he has included them in his fund.
Of course, with this approach, you will not directly receive any payments from successful cases and the dividend yield is a derisory 0.5%. So, any reward you do get, will need to come from an increase in the share price.
I’m always investigating new potential sources of income and litigation finance has certainly piqued my interest.
And, it’s a big bonus that this type of investing has virtually no correlation with any of the other assets classes that we regularly discuss in Income For Life.